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David Beckworth has a nice post over at his
site in which he argues that the Fed is not monetizing the debt.
He makes arguments that are similar to the ones I’ve previously made. But I think
the debate over monetization is even simpler than David notes.
The purpose of the fear mongering over the term
“monetization” is to imply that the Fed is funding the US
government. The term is used with an intended negative
connotation that implies some sort of solvency constraint, as if
the government couldn’t fund itself without this back stop which
would result in us looking more like Greece with yields surging
and on the brink of bankruptcy. This is just patently wrong
and those fear mongering over “debt monetization” have seen their
scary inflationary or default scenarios fall flat in recent
years. In other words, they’ve been wrong because they’ve
misinterpreted what the Fed is doing.

In the end, this debate is rather simple and has already been won
by those of us who predicted the market reactions in real-time .
If the Fed were needed to fund the US government then the
fear mongers would have all been right when QE2 ended and yields
would have surged because there would not have been enough demand
for US government debt. Investors like Bill
Gross called the end of QE2 “D-Day” because he was concerned
about a lack of funding when the program ended. I said, in
real-time that he would be wrong and that yields would not surge
and that there would be no lack of buyers.

Of course, Bill
Gross wasn’t the only one saying this. It was a common
refrain back in 2010. And despite their dire predictions,
the exact opposite occurred when QE2 ended. Yields
declined! The Fed was not directly funding the US
government and the Fed was not needed to fund the US government.
After all, the US government always harnesses its banking
system to fund its bond sales. To argue that the Fed needed
to back stop the Treasury is to misunderstand the dynamics at
work between the Primary Dealers and the US government.
This is just one of the many misunderstandings surrounding
QE2 and despite having already been thoroughly proven wrong, the
myth somehow still persists….